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Pressure on corporate profits
September, 20th 2008

Growth in the Centres direct tax revenues about 40% in the first five months of 2008 seems to be coming off its high. The impact of rise in cost of inputs, energy and other operating expenses on corporate earnings is now unmistakably apparent.

Companies are clearly expecting profit growth to slow, although topline growth continues to be healthy. This explains why the second instalment of advance tax of some companies (such as Indian Oil, ICICI) was lower than that paid by them in the corresponding period last year.

And, there are no surprises oil companies suffered as the government resisted passing on the full impact of the rise in crude oil prices to consumers, banking companies due to slowing credit growth as interest rates were lifted, and cement due to higher input cost and government intervention in pricing. Earnings could continue to be under pressure in the medium term due to the slowing economy and elevated prices of commodities and other raw materials.

There are enough indicators to suggest that. Industrial production grew only 5.7% in April-July 2008 compared with 9.7% in the corresponding period last year. The indirect tax collection too has slowed. Growth of excise collection was 3.7% in April-August 2008 over the corresponding period and by a mere 1.2% in August. Service tax collection growth is also displaying signs of moderating.

With demand compression slowly taking effect, companies may experience slowing growth of their sales revenue in the months ahead. The onset of the festival/wedding season may provide only a limited respite. Losses in the stock markets have depressed consumer sentiment, and that could affect spending. And, depreciating rupee would make imports more expensive.

The slowdown in the housing sector would have repercussion for several industries such as paints and electricals besides cement and steel. The Centre needs to respond to these early signals and widen the tax net further to make up for a shortfall in collections from regular taxpayers.

While measures such as annual information reports and tracking of high value purchases have improved compliance, the revenue department needs to do much for reducing evasion of both direct and indirect taxes. Else its budget arithmetic could go somewhat awry.

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